26th August 2011

Comment from Close AM ahead of Bernanke speech‏

Ahead of Bernanke’s speech, expectations as to what the Federal Reserve will do are so varied that they are now in a ‘catch-22’ situation – no matter what they do, it’s likely markets will be disappointed. If the Federal Reserve takes any action, it’s best if they prioritise two things: support for the mortgage market (through actions aimed at reducing long term rates, i.e. initiating more securities purchases or increasing the average maturity of the Fed’sholdings) or actions aimed at encouraging banks to increase lending (by reducing the rate of interest the Fed pays to banks on their reserves).

However, the Fed alone cannot save the world: at present, the crucible of distress is in Europe, where policy makers have yet to put forth a credible, solution to containing the contagion. We need to see a combination of unsterilised intervention, increases in the European stabilisation fund (EFSF) and some form of more direct fiscal alignment. More generally, across the western world, the crux of the problem is that we need both credible growth and fiscal austerity (seemingly incompatible goals) to reduce the mountains of debt that have piled up in the public sector. Without growth, we will see bankruptcies – but this time, not just of companies, but of banks and countries. That is why markets are so afraid, and gold is rallying.

At Close, we do not believe that the world will head into a double dip or contraction mode and we see attractive value in equity markets today, where companies in general are generating good earnings growth on healthy balance sheets. However, we will remain defensively positioned, until we see further confirmation of some of the following:

1.      Confirmation that the recent economic deceleration is influenced by temporary factors, and show some signs of improvement in Q4

2.      Some indication the emerging world has finished its tightening cycle and looking to pursue more stimulatory measures

3.      Proactive and credible policies to deal with the European sovereign crisis

4.      The US agrees the specific of its recently agreed fiscal tightening targets  

5.      Further unconventional measures, monetary policy support, adopted by the Fed and followed by other western central banks, particularly Europe

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